Table 1 shows the appropriation account for the year ended 31 December 2005. In an exam, the examiner might include the partners’ salary as wages and salaries in the income statement/profit and loss account. This would mean that the net profit would need adjusting, which would involve adding the partners’ salary to the net profit given in the question.
Table 2 shows the current account as at 31 December 2005.
Table 3 shows the capital account as at 31 December 2005.
Here is an illustrated example of the workings of a partnership business, and the treatment of goodwill on the admission of a new partner.
Jess and Tash are in partnership and share profits and losses in the ratio of 6:4 respectively. Jess is allowed an annual salary of $28,000 and Tash is allowed an annual salary of $25,000. The partners prepare their accounts annually at 31 December. The balances on the partners’ current and capital accounts at 1 January 2005 are as follows:
Partners Current account Capital account
Jess 20,000 CR 250,000 CR
Tash 30,000 CR 400,000 CR
Due to the expansion and success of the business, the partners admitted Sash into the partnership on 1 April 2005. Sash introduced $500,000 as capital. On that date, the partners valued the goodwill as $200,000. After the admission of Sash, the partnership arrangements are as follows:
- Profit and losses will be shared as follows:
– Jess: 50%
– Tash: 30%
– Sash: 20%
- Partners will be credited with 5% of the interest on their capital balance at the start of the year
- Interest on drawings will be charged at 8% per annum
- The partners’ drawings during the year are as follows:
– Jess: $40,000 to 31 March and $60,000 to 31 December
– Tash: $30,000 to 31 March and $50,000 to 31 December
– Sash: $50,000 to 31 December
- Sash will be allowed an annual salary of $20,000. Jess and Tash will continue to receive their annual salary
- The goodwill must be eliminated from the records
- During the year ended 31 December 2005, the partnership reported a profit of $526,000 after writing off a bad debt of $6,000 on 31 March 2006
- The partners’ annual salary was deducted as an expense in the income statement/profit and loss account under wages and salaries.
Prepare the following:
(a) Partners’ capital accounts as at 31 March 2005
(b) Partners’ appropriation account for the year ended 31 December 2005
(c) Partners’ current accounts as at 31 December 2005
(d) Balance sheet extract (Capital) as at 31 December 2005.
(a) Jess, Tash and Sash Partnership
Table 4 shows the capital account as at 31 March 2005.
Goodwill is the excess market value of the business over its book value. It is only fair that the partners who created this goodwill – Jess and Tash – should benefit from it, due to the hard work they have put into the business to get it up and running. If a partner joins the business when such surplus is present, then it is only fair that Sash pays for that benefit.
The accounting entries are:
Dr Partners’ capital account using new profit sharing ratio (PSR)
Cr Partners’ capital account using old profit sharing ratio (PSR).
(b) Jess, Tash and Sash
Table 5 shows the appropriation account for the year ended 31 December 2005.
Calculating the profit
Net profit as per question 526,000
Add bad debt written off (this should be written
off in the period that it relates to) 6,000
Partners’ salary should be treated in the
appropriation account and not the income statement/
profit and loss account 68,000
Net profit before appropriation 600,000
For the first three months to 31 March 2005, the net profit
would be: ($600,000 x 3/12) = $150,000 - $6,000 144,000
For the next nine months to 31 December 2005,
the net profit would be: ($600,000 x 9/12) = $450,000 450,000
(c) Jess, Tash and Sash
Table 6 shows the current account as at 31 December 2005.
(d) Balance sheet extract
Sash 51,595 414,000